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The 2 problems of unemployment

The problem of unemployment is usually seen as two separate problems:
The long-run problem, and
the short-run problem

The long-run problem focuses on reducing the natural rate of unemployment

The short-run problem focuses on reducing the cyclical rate of unemployment


Unemployment and the ABS

Unemployment is measured by the Australian Bureau of Statistics (ABS).
The ABS surveys 0.5% of Australian households chosen randomly. The survey is known as the Labour Force Survey.
Estimates of unemployment are derived from this survey


The 3 categories of employment and the ABS

Based on the answers to the survey questions, the ABS places each adult into one of three categories:
not in the labour force

The ABS considers a person an adult if he or she is aged 15 or older.

A person is considered employed if he or she has spent 1 hour of the previous week working at a paid job or family business.


Labour force

The labour force is the total number of workers, i.e. the sum of the employed and the unemployed.
A person who is neither employed nor unemployed is not in the labour force
Give examples


The unemployment rate

The unemployment rate is calculated as the percentage of the labour force that is unemployed.

unemployment rate = number unemployed/ labour force

multiplied by 100


Labour-force Participation

The labour-force participation rate is calculated by dividing the labour force (employed + unemployed) by the adult population (15 year plus)


Is unemployment measured correctly?

Discouraged workers &:

Other people may claim to be unemployed in order to receive financial assistance, even though they aren’t truly looking for work.
Is this an issue in Australia?
Underemployed: who are they?


Discouraged workers

Discouraged workers, people who would like to work but have given up looking for jobs after an unsuccessful search, don’t show up in unemployment statistics
Where do they show up then?
What is the effect on the unemployment rate?


How long are the unemployed without work?

Most spells of unemployment are short.
Most unemployment observed at any given time is long-term.
Most of the economy’s unemployment problem is attributable to relatively few workers who are jobless for long periods of time.
A little numerical demonstration: 14 people, out of which only 2 long-term unemployed (1 year each) and 12 short-term (1 month each)


Why Are There Always Some People Unemployed?

In an ideal labor market, wages would adjust to balance the supply and demand for labor, ensuring that all workers are fully employed.

There are two main types of natural unemployment: structural and frictional


Frictional unemployment

Frictional unemployment refers to the unemployment that results from the time that it takes to match workers with jobs. Search for the jobs that are best suit their tastes and skills. Inevitable because the econocmy is always changing.


Job search

the process by which workers find appropriate jobs given their tastes and skills.
results from the fact that it takes time for qualified individuals to be matched with appropriate jobs
Search unemployment is inevitable because the economy is always changing.
It takes time for workers to search for and find jobs in new sectors.


Structural unemployment

Mismatch between the skills required and offered


‘classical unemployment’ occurs due to

Minimum-wage laws.
Efficiency wages.


minimum wages

When the minimum wage is set above the level that balances supply and demand, it creates unemployment.
The national minimum wage is currently $18.29 per hour or $694.90 per 38 hour week (before tax).


Minimim wage graph

Photo in favourites on phone 13/8/18



A union is a worker association that bargains with employers over wages and working conditions.
In the 1970s and 1980s, when unions were at their peak, more than half of the Australian workforce was unionized.
A union is a type of cartel attempting to exert its market power.


The theory of efficiency wages

Efficiency wages are above-equilibrium wages paid by firms in order to increase worker productivity.
The theory of efficiency wages states that firms operate more efficiently if wages are above the equilibrium level.
The Ford example


Henry Ford’s experiment

Henry Ford introduced the assembly line technique in auto production, thereby ushering in a productivity revolution
In 1914, Ford began paying his workers $5 per day, which was far above the norm
Turnover and absenteeism fell.
Productivity rose so much that Ford’s costs fell
Henry Ford himself called the $5-a-day wage “one of the finest cost-cutting moves we ever made”


A firm may prefer higher-than-equilibrium wages for the following reasons:

Worker health
Worker turnover
Worker effort
Worker quality


Worker health

: Better paid workers eat a better diet and thus are more productive.


Worker turnover

A higher paid worker is less likely to look for another job.


Worker effort

Higher wages motivate workers to put forward their best effort.


Worker quality

Higher wages attract a better pool of workers to apply for jobs.


Asymmetric Information

In many transactions, one individual has better information than the other.

Adverse selection
Moral hazard


Adverse selection

Adverse selection occurs when one person knows more about the attributes of a good than another and, as a result, the uninformed person runs the risk of being sold a good of low quality.
Unknown type
Good/bad quality worker
Screening and signalling (education)


Moral hazard

Moral hazard occurs when one person (the agent) is performing some task for another person (the principal). Because the principal cannot perfectly monitor the agent’s behaviour, the agent tends to undertake less effort than the principle considers desirable.

Unknown action
Will work hard vs be lazy
Can you think of an incentive contract?
Unemployment benefits?


Production and Growth

A country’s standard of living depends on its ability to produce goods and services.
Within a country there are large changes in production/standard of living over time.
The same is true across countries
When talking about economic growth we mean growth of real GDP...


Economic growth - Compounding

Annual growth rates that seem small become large when compounded for many years.
Compounding refers to the accumulation of a growth rate over a period of time.


Australia and compounding

In Australia between 1950 and 2011, average income, as measured by real GDP per person, has grown by about 1.9 percent per year.
This has led to a 3.2 times increase in the real GDP per capita (living standards)